How to End the Monopoly and Recover the Money

In the latest development in the county’s continuing liquor monopoly saga, the County Executive has established a task force to explore options for scaling back or eliminating the monopoly. One condition applies: the monopoly earns money for the county and the Executive does not want to lose it. Last February, he told Bethesda Magazine, “I have no problem with privatization per se, but we need to make sure the county’s residents and taxpayers are protected on the financial issue.”

That’s a reasonable point of view. Here’s a proposal to End the Monopoly without taking a financial hit.

First, let’s recall that the goal of last winter’s End the Monopoly campaign was never to abolish the Department of Liquor Control (DLC). Rather, we were seeking to allow private sector competition with the DLC at both the wholesale and retail levels. Licensees would be able to buy from the county, private wholesalers or both and consumers would be able to buy all beverages, including spirits, from county stores, private stores or both. That does not mean that DLC would get wiped out. Indeed, it has one competitive advantage that no private wholesaler has: it is a one-stop shop for all alcoholic beverages. Some licensees are willing to tolerate DLC’s problems in return for the convenience of dealing with one bill and one truck. DLC’s Acting Director claims that their performance is improving and the county employee union President told the latest meeting of the task force that he has spoken to dozens of retailers who wish to stay with DLC. If they are correct, private competition will not eliminate DLC, but it could reduce its revenues.

The closest relevant example to what would happen if DLC were exposed to competition is Worcester County, Maryland, which opened up its spirits monopoly in 2014. Worcester’s DLC Director testified to the MoCo Delegation that within a year, the county had lost 42% of its wholesale business to private competition but had kept 96% of its retail business. Now Worcester County’s monopoly was run far more poorly than MoCo’s DLC as it was found guilty of massive violations of state law back in 2010, so MoCo’s DLC could fare much better with competition. But for the sake of argument, let’s use its experience as a starting point.

Any analysis of what would happen to MoCo’s DLC under competition must recognize that the liquor monopoly makes two payments to the county: a direct return to its general fund and debt service paid on bonds guaranteed by liquor profits. Potential shortfalls in both those areas must be addressed.

The General Fund

DLC’s operating profits, projected to be $20.7 million in FY17, are paid directly into the county’s general fund. That amount accounts for 0.4% of the county’s $5.3 billion operating budget. What would happen to those profits if the private sector were allowed to compete with DLC? According to the county’s Office of Legislative Oversight, DLC’s FY14 revenues were split pretty evenly between wholesale ($136 million) and retail ($127 million) operations. If Worcester County’s experience occurred in MoCo, 42% of the wholesale revenue and 4% of the retail revenue would be at risk from competition, so DLC’s total revenue would decline by 24%. If DLC’s operating costs scale with its operating revenues, its net income would fall by $5 million.

Second, new tax revenues will be available in a world of competition. The state’s Bureau of Revenue Estimates released a report last year finding that if DLC were completely abolished, $22.8 million in tax revenues would be generated, mostly from customer repatriation. (That is actually larger than DLC’s return to the county’s general fund.) The problem is that only $1.8 million would accrue to the county in local income taxes, while the rest would go to the state (primarily through sales taxes). The solution is to have the state share its incremental revenue increase with the county for a period of time. After all, if the county is giving up a financial asset, it should share in the returns from that.

A formula could be constructed that ties incremental increases in state revenue from alcohol sales in MoCo to DLC’s reduced income. For example, in Year X, if DLC earns $5 million less than its baseline and the state earns $6 million more than its baseline, up to $5 million could be returned to the county. The formula should cap returned receipts to the county at the amount that the state gains so that the state doesn’t lose money. And it could be temporary and transitional since at some point MoCo would be expected to behave like nearly all other counties in the nation and pay its bills with no liquor monopoly.

The math is clear: it’s entirely possible for the county to suffer no net losses at no cost to the state with incremental revenue sharing and a few more liquor stores.

The Bonds

The county has issued three tranches of revenue bonds guaranteed by liquor profits, the last of which matures in FY33. The outstanding balance on the bonds is $114 million as of June 30, 2014 and DLC is projected to pay $10.9 million in debt service on them in the current fiscal year. If the liquor profits available to pay for these bonds were to disappear, another source of revenue must be found to replace them.

Such a revenue source can be easily found in the county’s budget: county cable franchise fees. Federal law allows local jurisdictions to charge cable companies in return for using public right-of-way. The maximum amount allowed by federal law – 5% of cable bills – is contained in the franchise agreements the county negotiates with Verizon, Comcast and RCN. Because cable bills rise every year, the county gets more money out of this as time passes. Also, because this money is unencumbered by DLC’s employee and capital expenses, it is not subject to cost changes like DLC’s profits are. Cable franchise fees are actually a more stable revenue source to guarantee bonds than are liquor profits.

According to the county’s cable budget, the county is projected to collect $17.7 million in cable franchise fees in FY17. Of this amount, $3.8 million is passed on to the Cities of Rockville and Takoma Park and the Maryland Municipal League in compensation for use of municipal rights of way, leaving $13.9 million available. The county has obtained legal advice holding that the county can do virtually whatever it wants with the 5% cable franchise fees.

How is the cable money currently spent? Most of it is given out to the PEG (public/education/ government) TV channels. The two largest are the county’s in-house news channel, County Cable Montgomery, and the non-profit Montgomery Community Media, which is also financed by private sector contributions. The problem is that no one knows how many people actually watch this programming. The huge majority of their YouTubeclips get a few dozen views each at best. Is this truly worth millions of dollars of public money?

The county could easily retire its current liquor bonds and replace them with new bonds that are guaranteed by both liquor profits and cable franchise fees. Liquor profits would be the first source of debt service payment, with any shortfall covered by cable fees as a supplement. Even if liquor profits entirely disappear, the $13.9 million in annual cable fees – an amount that has been growing steadily for years – could cover the $11 million in annual debt service by themselves. And over the long term, this arrangement would be temporary as the bonds will eventually be paid off.